To defend the yen, did Japan sell U.S. Treasuries?

Fed custody data shows that during the period when Japan was suspected of intervening in the foreign exchange market, its holdings of U.S. Treasuries saw their first decline in a month. The market is abuzz about whether Japan cashed in U.S. Treasury bonds to raise funds to support the yen.

For the week ending May 6, Fed data shows that the balance of U.S. Treasury bonds held in custody for foreign official and international accounts decreased by $870 million, down to $2.73 trillion.

Furthermore, since the end of April, the USD/JPY exchange rate has decoupled from the movement of 10-year U.S. Treasury yields.

According to Bloomberg estimates, during the same period the Japanese Ministry of Finance spent about $54.7 billion to purchase yen. Rodrigo Catril, Senior FX Strategist at the Australian Bank in Sydney, stated:

The change in custodial accounts seems to coincide with the event of Japan's Ministry of Finance instructing the Bank of Japan to intervene.

JPMorgan's Yuxuan Tang pointed out that the Bank of Japan allocated funds from reserves, enabling Japanese authorities "to operate during U.S. trading hours, when the U.S. Treasury market is most liquid, which helps minimize market disruption."

He added that Japanese authorities tend to use short-term U.S. bonds in such operations, and that's the reason for this preference.

Japan is the largest foreign holder of U.S. Treasury bonds. If Japan's holdings of U.S. Treasuries are actually reduced, it will put further upward pressure on U.S. bond yields.

Actual selling scale may far exceed the drop in custodial accounts

It is notable that the $870 million decrease shown in the custody account data may be just a small part of the impact of this intervention on the supply and demand of the U.S. bond market.

Shusuke Yamada, FX and Rates Strategist at Bank of America in Tokyo, pointed out in a research report that, looking back at historical intervention cases, the cash portion of Japan's foreign exchange reserves rarely shows a significant decrease. He stated:

If the same situation applies this time, it means the relevant bond market—usually considered to be the U.S. Treasury market—will see a deterioration in supply and demand by about $7 billion.

This estimated scale far surpasses the decrease reflected in the Fed custody account data.

This potential selling of Japanese bonds comes at a time when the U.S. Treasury market is already under pressure. Rising oil prices, along with worries that a possible Iran war could worsen the U.S. fiscal deficit, have been continuously pushing up U.S. Treasury yields.

Rodrigo Catril pointed out that, based on historical experience, FX market intervention is usually sporadic, but "if this becomes the norm, it could constitute a substantial problem for the U.S. Treasury market."

Against this backdrop, it is reported that U.S. Treasury Secretary Janet Yellen is about to visit Japan and is expected to meet with Japanese Prime Minister Sanae Takaichi, Finance Minister, and Bank of Japan Governor Kazuo Ueda.

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